Let's Have a Beer and Talk Derivatives

From a Milwaukee office overlooking the original Miller Brewing plant, Craig R. Reiners haggles over futures contracts for barley, the primary grain in Miller Genuine Draft beer. He also negotiates aluminum futures, because the metal is used in the millions of beer cans the company produces every year, and works out more esoteric deals, such as swaps and collars on the natural gas that fires the brewery outside his window. Reiners' job is to insulate MillerCoors from commodity price fluctuations and ultimately protect the Great American Beer Drinker from having to pay more for a six-pack.

MillerCoors and other brewers also buy massive quantities of wheat, rice, malt, sugar, and corn. The prices of all those commodities can swing wildly, so the financial products known as derivatives—hedges on whether prices will rise or fall—help the brewer lock in a price range that smooths profits. Now the Obama Administration is looking to prevent another financial crisis by regulating the derivatives MillerCoors uses. Reiners says Washington can make his job a lot harder. "It's too bad we're being painted with the same brush as the people who really abused the system," he says.

Beer isn't what comes to mind when lawmakers talk about financial engineering. But MillerCoors, Anheuser-Busch (BUD), and other brewers are major users of derivatives, so they are at the center of an esoteric debate over how tightly to regulate the thriving over-the-counter derivatives trade, which occurs outside commodity exchanges. An estimated $605 trillion worth of private contracts are outstanding. This sort of financial contract was a cause of the global meltdown, with American International Group writing billions in credit default swaps, a form of derivative that insures against the failure of corporate or mortgage bonds, which went bad when housing collapsed.

The brewers are lobbying to stop a proposal by President Barack Obama that would force them to trade derivatives on a public exchange or process them through a clearinghouse—a company that executes the trade and settles the contract when it comes due. The White House would effectively require derivatives users to tie up their cash in the form of collateral, which the clearinghouses would collect. Obama says the idea would reduce the risk that cascading defaults could destabilize the financial system, helping avoid a repeat of the $182 billion bailout of AIG.

The brewers say collateral can be costly and unpredictable, changing as the market price of the underlying commodity changes and locking up millions of dollars. Reiners, along with MillerCoors lobbyist Richard Crawford, has traveled to Washington to make the case to lawmakers. "This proposal would tie up well over $100 million a quarter," he says. "That's money that's parked, and you can't use it for anything else."

In December the House exempted brewers and other end users of derivatives from the clearinghouse and collateral rules. Now the Administration is pushing the Senate, which has not yet approved a measure, to narrow this exemption, potentially forcing brewers to ante up collateral. The Senate Banking Committee did not exempt end users in a bill it approved last month; the beer companies hope to change that.

Beer lobbyists have met with the Senate Agriculture Committee staff several times in recent months, arguing that an exemption is justified. They will descend on Capitol Hill again in late April, now that the Senate is about to debate derivatives on the floor as part of the financial regulation bill. "We didn't cause the problem," says Dorothy Coleman, vice-president for tax policy at the National Association of Manufacturers (NAM). "This isn't speculating. We're not making money off these transactions."

As part of their pitch, the brewers remind lawmakers that they buy billions of dollars of farm commodities and employ thousands of union workers. The brewers are planning to come with handouts showing the impact of their industry on each state, says one industry official involved in the congressional visits. The handout for Iowa, for example, shows the beer industry was responsible for 14,325 jobs and $704 million in economic activity in the state in 2008.

Anheuser-Busch controls almost half the U.S. beer market and operates a dozen breweries. It owns 11 distributors and works with 600 independent wholesalers. It buys rice in Arkansas and California, grows hops in Idaho, and makes glass bottles in Texas. MillerCoors, which controls about 30% of the U.S. market, brews in nine states. It buys all its corn and most of its barley—some $500 million a year—in the U.S.

The brewers are also generous donors. Anheuser-Busch's political action committee and employees have given $471,000 to federal candidates and political parties for the 2010 election cycle, according to the Center for Responsive Politics. MillerCoors' PAC contributed $79,000 in the same period. The National Beer Wholesalers Assn. donated $1.7 million.

Anheuser-Busch InBev had more than $1 billion in aluminum swaps, $69 million in corn swaps, and interest rate swaps—used to smooth swings in currencies—worth more than $80 billion, according to its financial statements. Anheuser-Busch officials didn't respond to calls for comment.

If aluminum swaps—primarily private contracts between two parties—were forced to go through a clearinghouse, Anheuser-Busch would have to put up as much as 6% of the cost of a contract. "If you impose margin requirements on these companies, you're either taking away their ability to manage their risk or taking away their working capital," the NAM's Coleman says. Anheuser-Busch's $1 billion in aluminum swaps would require collateral whose value could swing by $10 million a day if the price of the metal were to change 1%, says Craig Pirrong, a finance professor at the University of Houston.

Gary Gensler, chairman of the Commodity Futures Trading Commission, which oversees most swaps, says the benefit of a safer capital market outweighs those concerns. "We have a real risk that society is bearing," he says. What does that have to do with the price of beer in Buffalo? Plenty.

    Before it's here, it's on the Bloomberg Terminal.